The Americas

Canada's economy

Still safe and sound?

THE last time the global economy cooled off in a hurry, frigid Canada proved the best place to take shelter. Its tightly regulated banks had avoided subprime mortgages entirely, its housing market was reasonably valued and its sound public finances gave the government ample room for stimulus. Moreover, strong Asian demand for Canadian commodity exports had tied the country's fortunes to the world's fastest-growing economies. While the United States and Europe plunged deep into recession in 2008, Canada's GDP barely shrunk at all. And when the recovery began the following year, Canada quickly returned to growth.

The events of the past few weeks have sharply increased fears of a double-dip recession elsewhere in the developed world. With worries about Europe's sovereign debt threatening Spain and Italy (and even possibly France); America's economy stagnating and its credit rating downgraded; and central banks in the developing world applying the brakes to control inflation, investors are frantically searching for safe havens. Will Canada prove as sturdy this time as it did in 2008?

Most of Canada's economic advantages remain intact. Employment is higher now than it was when the current Conservative government took office in 2006. Its battle-tested financial system is a source of strength. The government has been cutting the budget deficit since the recovery began in an effort to return it to balance by 2015, making Canada one of the only rich countries capable of further Keynesian pump-priming.

Moreover, Canada's highly diversified economy automatically gives it some cushioning from external shocks. Because the country exports so many natural resources like oil, minerals and timber, its currency tends to track commodity prices. The boom of the last decade has propelled Canada's dollar to parity with America's, forcing its manufacturers to become highly efficient to survive. If commodity prices fall and the loonie, as the currency is known, takes a tumble, Canadian producers of cars and machinery will gain competitiveness and should be able to expand their output. “In relative terms [to the rest of the world], Canada could hardly be positioned better,” says Finn Poschmann, an economist at the C.D. Howe Institute, a think tank in Toronto.

Some economists express concern that Canada has followed a similar trajectory in recent years to that of the United States leading up to its financial collapse in 2008. Canada's trade surpluses have turned to deficits. Housing prices have soared since the economy started its rebound in 2009. And household debt, at 147% of GDP, is among the highest in the OECD. But Canada's balance of payments will improve if its dollar weakens. And with low interest rates and plain-vanilla mortgages, a full-blown Canadian credit crunch seems unlikely.

The biggest threat to Canada's economy is its intrinsic vulnerability to the outside world. With a population of 30m, the country does not consume enough on its own to maintain output if foreign demand dries up: exports make up one-third of its GDP. “Canada is not an island,” Jim Flaherty, the finance minister, said earlier this week. “We are a trading nation.” The world's rising economic tide has lifted Canada higher than most rich countries over the past decade. A falling one could pull it down nearly as far.

Is this an ad, because I think I must be dreaming. Canada is extremely vulnerable to a housing-market collapse. The value of my own home increased threefold in eight years. Meanwhile, interest rates hover at near-zero levels.

Raise those rates and those who think that they can eternally live off rising home prices are in for quite a shocker. Those who must deleverage will experience unprecedented pain.

The biggest concern is that Canadians continue to pile on more household debt. Canadians’ debt-to-assets ratio has risen to its highest level in more than 20 years. The increases in housing prices are driven by increasing willingness to take out bigger mortgages. As Bank of Canada Governor Mark Carney recently observed, "This cannot continue."

Too much debt is a problem for Western democracies in general and where there isn't an impeding crisis for public finances be on guard for a developing one in private finances.

With what's happening in the rest of the world, an intelligent government in Canada should realize that things are going to get tougher down the road. We should be cutting the deficit more aggressively, instituting a freeze on public sector hiring and encouraging more health care delivery experimentation by the provinces to arrive at a new best practise model to move us beyond repeatedly throwing money at a broken system. Quebec and Ontario continue to be fiscally irresponsible. The Feds enable Quebec in this profligacy. They need to grow up while we have time to prepare for the storm that is coming.

I am not particularly concerned about the housing unlike some friends. Yes, there is likely a bubble but, not on the scale of the USA and in a far safer environment (CMHC anyone?.)
A hike in interest rates will hurt many but, will not take down the banks like south of the border. Beside that, the bubble is in the cost not the supply. The market is not over supplied to the level of USA and immigration makes a large slice of the demand side. Canada has a far more responsible government in regard to fiscal matters than our neighbours and has vast resources to exploit (for good or bad). Unlike consumer products, the world will be buying commodities for the forseeable future and industry is ready to serve with new pipelines and new ports. In regard to individual debt, some provincial govs are already pushing people to consolidate and pay with hotlines and debt services. Its not all roses and ice-cream and I may be naive but, my money (literally) says, "Still safe and sound".

"THE last time the global economy cooled off in a hurry, frigid Canada proved the best place to take shelter. Its tightly regulated banks had avoided subprime mortgages entirely, its housing market was reasonably valued and its sound public finances gave the government ample room for stimulus."

No wonder housing got unaffordable for locals. Can't wait to see the housing bubble burst.